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What is a Blockage Discount?
Blockage discount – also sometimes referred to as the blockage factor – is the discounted price or value the market gives stocks when a block of shares is sold. The exact number of shares constituting a block varies. However, any time more than 10,000 shares of a company’s stock are introduced into the market at once, the blockage discount typically comes into effect. In the bond market, a “block” is characterized by $200,000 worth or more of securities being introduced into the market at one time.
How a Blockage Discount Works
A blockage discount is closely tied to supply and demand. The law of supply and demand says that within the market there is a certain amount of demand for a good, service – or in this case, shares of a company. When the market is flooded with a significant increase in the supply of shares, the value per share goes down. This is because of the greater access and availability of the shares without a corresponding increase in demand. In reality, it means that demand also decreases because the shares are so readily available.
Sellers looking to cash in on their large block of shares must recognize the imbalance created when they flood the market with a surplus of shares. For this reason, the seller also must recognize that the market will lower the value of shares, meaning the original share price goes out the window. Sellers looking for a quick turnaround are often penalized for their hastiness to earn a huge sum, and it often forces them to take a significantly discounted cut per share.
Blockage Discount Percentages
In most cases, the market will discount a block of shares anywhere between 1% and 15%, although there is the potential for a 0% discount as well if the stock is in particularly high demand. Market analysts and traders – in order to accurately determine the size of the discount – must effectively study all historical information about the company, the market’s response to similar block offers in the past, and discounts given to blocks of shares from similar companies.
It’s also important for such individuals to study the economy as a whole, as well as the industry the company operates in. Understanding the market’s response to the industry and companies within it in the near-recent past is a helpful bit of information for analysts to get a better understanding of the scope of the potential blockage discount for a company within a given sector.
Final Word
Blockage discounts – while not destined to occur – are a fairly common response from the market. When a seller changes the supply and demand balance by introducing a large group of shares into the marketplace, it is a nearly foregone conclusion that the market will respond by assigning less value to each share. Sellers should keep this fact in mind and avoid selling large blocks of shares when possible.
Related Readings
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:
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